3rd_ inventory classification

7/29/2019 3rd_ Inventory Classification

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INVENTORY CLASSIFICATIONInventory is first classified into four broad groups

which are: Production inventory

In-process inventory

Finished goods inventory Inventory of MRO items


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Production InventoryThis includes:

Raw materials

Parts and components that are directly used in theproduction process and go into the making of the finalproduct.

Two important factors that determine the size of rawmaterial inventory are:

1. Internal factors: This includes the technology ofproduction, the criticality of the item and the lead timerequired for procurement

2. External factors: The suppliers lead time to manufacture,availability of the raw materials in the market, seasonalityif any, credit situation, government restriction etc.

(..cont.)


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Production Inventory(contd.)

Organizations, especially those in the FMCG

and engineering goods, do not always producetheir output from the raw materials. Some oftheir components are brought from other

vendors. This enables them to concentrate more on

critical parts and assembling.

Many of the companies are going towards thisroute these days, including Dell, GM,Volkswagen etc.


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MRO Inventory

MRO stands for Maintenance, Repair andOperating supplies.

These items are very much essential in theproduction process although they do not go into

making the final product. They include:1. Consumables: lubricating oils, safety items,

electrical items such as lights, fans etc.

2. Spare parts: Parts of machines

3. Packing material: In the pharmaceuticalindustry, packing cost is substantial. In somecases, packing materials are a part ofconsumables.


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In-Process Inventory

They are also called WIP (Work-in-process)inventory.

They comprise of the semi-finished products atvarious stages of production process.

Typically, the output of one stage in an assemblyline is the input of for the next stage.


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Finished Goods Inventory

This comprises of all the final products madeby the company, ready for shipment and sale.

The purpose of this inventory is to assure aconstant supply to the distribution channels.


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.

In most of the organizations, the Production

inventories and MRO inventories represent the

biggest segment of the total inventory system.


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Classification for financial

reporting

Inventories are treated as of the working capital in theBalance Sheet and they are classified as:

1. Goods in transit (GIT) or Stores in transit (SIT): Thisincludes all materials which have already been paid for but

not yet received in the stores and accounted for.2. Stores: All materials physically held at the store, which

have been accounted for.

3. Work in process (WIP): Materials issued to the shop floor

which have not yet become finished goods; these arevalue added materials to the extent of labor and handlingcosts incurred.

4. Stock in trade (SITr): These include all finished goods,ready for sale.


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Degree of Inventory Control

implies

1. Sophistication in demand forecasting2. Frequency of review of Inventory position

3. Frequency of reviewing Inventory replacement

policy4. Rigor in vendor selection / review


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Selective Inventory Control

It is not possible and feasible to exercise strictmanagement inventory control over all theitems.

It will only be too much effort with too littlebenefit.

Hence, the principle of management byexception is applied here.

The items are classified based on certaincriteria to facilitate selective inventory control.

Such control minimizes waste of efforts as wellas confusions.


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.

The degree and character of controls shoulddepend on:

The necessity of control The relative importance of the material (An

item may be important, but there may notbe any necessity to control its inventory.)

The particular characteristics of the material


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Inventory CatalogueIt is necessary to have a list of items with details of

each item as given below. (This list is calledInventory Catalogue.)

An identifiable individual number or a code for eachitem: numeric, alpha-numeric etc.

The description of the item: This should alsoinclude the dimensions, weight, identity of themother equipment, drawing numbers, part numberetc.

Annual consumption of at least last three years

Name of suppliers who have supplied the item inlast three years

Average life of the item

Stock of the item


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Inventory Catalogue The inventory catalogue serves many purposes.

A seasoned storekeeper can see the codenumber and identify the item.

It helps to identify similar items in the inventory

and helps in standardization and varietyreduction.

In computerization of the inventory records, thecatalogue number becomes the identifyingnumber for an item.

By logging in the catalogue number, the historyof an item can be known.


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Classification: ABC Analysis ABC analysis is the most commonly used

method for classification. This is based on the annual consumption value.

Based on Pareto Analysis which identifies vital

few, trivial many. It is often seen that a small number of items

account for a major portion of the totalconsumption expenditure and several itemstogether are many in number but account for asmall portion of annual expenditure.

Actual percentages vary from one firm to

another.


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Classification: ABC Analysis In general, 10% of the items account for 70% of

the cost and they are called A class items andrequire highest degree of control.

Similarly, 70% of the items account for only 10%

of the cost. And they are called C class itemsand should not be given much attention.

The remaining items are called the B classitems.


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How to conduct ABC Analysis? As a first step, once the items in the inventory have been

properly identified, their usage record for a complete

operating cycle is built. Usually, the operating cycle is one year in most of the

companies.

Then the items are sorted and ranked in the decreasing

order of their consumption value. The value of each item is next as a percentage of the

total.

By computing successive cumulative percentages, onecan determine which items make up the first 70% of

inventory investment, the next 20% and the balance10%. The groups are called the A, B, and C respectively.

Solve one problem as given in MS-Excel.


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Importance of ABC Analysis? ABC classification is of immense importance to the

management.

It provides the basis on how to allocate funds and timeof personnel w.r.t. procurement as well as refinement ofcontrol over the individual inventory items.

It would be a waste of time and effort to pay muchattention to the C-class items.

Separate policies are usually adopted for three classes.

A-class items need to be monitored on day-to-day basis.

Decision on C-class items are based on the objectiveslike, minimizing acquisition cost, maximizing servicelevel and reliability, minimizing inventory investment,minimizing indirect costs associated with the items andutilizing personnel and their time effectively.


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XYZ Analysis XYZ classification is based on the stock value of the

items. Items having a very high stock value are classified as

X. Items with least stock value are classified as Z.

The method of arriving at the classification is the

same as for ABC classification. Only instead of

taking annual consumption value into account, the

annual stock value for each item should be taken

into account.


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VED Analysis Certain items are important by the impact of their

absence. Their absence can cause a holdup in productionand result in high costs, shut down or slow down ofproduction/productivity, a great impact on overall sale.The above items may or may not be priced high but theirstockout costs are indeed very high. These items are

called vital items. E stands for essential. These items are not very

critical to production, their stockout costs are stillexpensive.

D stands for desirable- it is better to avoid stockoutsfor these items, although a stockout for a short periodwill not affect the production.

The classification is done on the basis of shortage costs

of the material.


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VED Analysis Various forms of VED classification exist.

James A.G.Krupp, Director of Corporate Materials atEchlin Inc had classified the materials in his orgn.

According to its service or operating importance on

a 3-point scale.

1. Critical

2. Medium

3. Non-critical

(see the matrix of safety stock (SS) of VED Vs. ABC

classification in MS-Excel)


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FSN Analysis Items can also be classified as fast moving, slow moving or

non-moving based on their pattern of issue from the store.

This denotes how soon a material is consumed/sold after ithas been purchased and taken into stock.

This classification helps in controlling obsolescence.

F: very fast moving and used once in every week or say,every month.

N: items which are not consumed/sold even once in say twoto three years are classified as non-moving. Keeping toomany non-moving items in the inventory is dangerous. Theyblock useful working capital and eat into the profitability ofthe company. Attention needs to be paid to them to declare

them as surplus or obsolete and find alternate uses of thematerial or else dispose them off, so far it leads to moneyrealization as well as space saving.

S: All items which are neither Fast or non-moving aretermed as slow moving items.


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HML Classification This classification is based on the unit price of

material. H: High price per unit of the item

M: Medium price per unit of the item

L: Low price per unit of the item This classification is particularly relevant when it

comes to deciding the procedure to be followed for

procurement.


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PQR Classification Besides value and criticality of the items, another

commonly used method to classify items is based on theshelf life of the item.

Shelf life of an item is defined as the useful life of theitem, that is, the period in which the item can display thecomplete characteristics, for which it is meant.

P: Items having a low shelf life, and thus requiringfrequent attention

R: Items having very long shelf life and thus requiring theleast attention

Q: all other items which are neither in P nor in R

This classification is more relevant for perishable itemssuch as confectionaries etc.

Time period for PQR classification varies from oneindustry to another.


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SDE Classification This classification is based on the ease of obtaining

an item. S: Scarce itemssuch items are not easily available

in the market and might require source

development or else it might be an item which is

difficult to manufacture or there are only one or twomanufacturers who have to be given orders severalmonths in advance and so on. All these items require

special efforts for procurement.

D: Difficult to obtain

E: Easy to obtain

An item which is A as well as S needs completely

different methods for inventory management.


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GOLF Classification This classification is based on the nature of the

source for an item. G (Government): Items which are canalized through

the State Trading Corporations, MMTC etc., come

under G class. Common procedures for inventory

management may not apply to them. Lead timesare longer.

O (Open market): For such items, there are a

number of suppliers. Quality and availability is good. L (Local sources):

F (Foreign sources):


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SOS Classification This classification is based on the nature of the time

of availability for an item. S: Seasonal: such as jute, cotton, sugarcane etc.

OS: Off-Seasonal: Items which are not seasonal


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. See several commonly used matrices in MS-Excel

3rd_ inventory classification

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